Restaurant denied section 501(c)(3) exemption for commercial operations

Plain-English summary

An organization sought retroactive reinstatement of section 501(c)(3) status after an earlier exemption was revoked for failing to file required returns. Its articles contemplated international schools focused on personal healing, but its only actual activity over several years was operating a restaurant open to the public. The restaurant charged prices and kept hours similar to nearby businesses, competed with other eating establishments, and generated all of the organization's income. The IRS concluded that the organization operated for a substantial commercial purpose rather than exclusively for charitable or educational purposes. Because the organization did not protest the proposed adverse determination within 30 days, the denial became final and contributions were not deductible under section 170.

Ruling snapshot

• Question: Does an organization whose only activity is operating a public restaurant satisfy the section 501(c)(3) operational test?
• Outcome: denied, because the restaurant was a substantial nonexempt commercial activity
• Key authorities: IRC §§ 501(c)(3) and 513; Treas. Reg. § 1.501(c)(3)-1; B.S.W. Group, Easter House, Living Faith, Harding Hospital, and La Verdad

Full text (IRS public release)

Transcriber's note: this document is a scan. Obvious OCR errors in headings, the legend, spacing, bullet symbols, court abbreviations, and website text were corrected by comparison with all eight page images. Redacted blanks remain blank, and the wording is otherwise preserved verbatim.

Department of the Treasury
Internal Revenue Service
P.O. Box 2508
Cincinnati, OH 45201
Date: November 5, 2019

Employer ID number:

Number: 202005021
Release Date: 1/31/2020 Contact person/ID number:

Contact telephone number:
Form you must file:

Tax years:

UIL Number: 501.03-30, 501.36-03

Dear                         :

This letter is our final determination that you don’t qualify for tax-exempt status under Section 501(c)(3) of the
Internal Revenue Code (the Code). Recently, we sent you a proposed adverse determination in response to your
application. The proposed adverse determination explained the facts, law, and basis for our conclusion, and it
gave you 30 days to file a protest. Because we didn’t receive a protest within the required 30 days, the proposed
determination is now final.

Because you don’t qualify as a tax-exempt organization under Section 501(c)(3) of the Code, donors can’t
deduct contributions to you under Section 170 of the Code. You must file federal income tax returns for the tax
years listed at the top of this letter using the required form (also listed at the top of this letter) within 30 days of
this letter unless you request an extension of time to file.

We’ll make this final adverse determination letter and the proposed adverse determination letter available for
public inspection (as required under Section 6110 of the Code) after deleting certain identifying information.
Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, follow the instructions in the Notice
437 on how to notify us. If you agree with our deletions, you don’t need to take any further action.

We’ll also notify the appropriate state officials of our determination by sending them a copy of this final letter
and the proposed determination letter (under Section 6104(c) of the Code). You should contact your state
officials if you have questions about how this determination will affect your state responsibilities and
requirements.

Letter 4038 (Rev. 7-2014)
Catalog Number 47632S

If you have questions about this letter, you can contact the person listed at the top of this letter. If you have
questions about your federal income tax status and responsibilities, call our customer service number at
1-800-829-1040 (TTY 1-800-829-4933 for deaf or hard of hearing) or customer service for businesses at
1-800-829-4933.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosures:

Notice 437

Redacted Letter 4036, Proposed Adverse Determination Under IRC Section 501(c)(3)
Redacted Letter 4038, Final Adverse Determination Under IRC Section 501(c)(3) - No Protest

Letter 4038 (Rev. 7-2014)
Catalog Number 47632S

Department of the Treasury
Internal Revenue Service
Cincinnati, OH 45201
Date: August 26, 2019

Employer ID number:
Contact person/ID number:
Contact telephone number:

Contact fax number:

Legend:
B = Date
C = Date
D = State
E = Name
x = Number

UIL:
501.03-30
501.36-01

Dear                         :

We considered your application for recognition of exemption from federal income tax under Internal Revenue
Code (IRC) Section 501(a). We determined that you don’t qualify for exemption under IRC Section 501(c)(3).
This letter explains the reasons for our conclusion. Please keep it for your records.

Issues

Do you qualify for exemption under Section 501(c)(3) of the Code? No, for the reasons stated below.

Facts

You were previously granted exemption under Section 501(c)(3) of the Code on B. Your exemption was
revoked due to the non-filing of Form 990 for       consecutive years. Accordingly, you submitted this new
Form 1023, application for exemption for retroactive reinstatement.

You were incorporated on C in E. The Articles of Incorporation state that you are creating schools
internationally to encourage individuals to participate in their personal healing, which in turn will assist the

process of healing on a global scale.

Your only activity you have conducted since your inception of x years ago is the operation of E. E is a
restaurant that is open to the general public from       -       for brunch/lunch during the hours of

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

In addition, E:

• Serves healthy food options consisting of vegan, vegetarian and gluten free dishes at prices similar to
that of other establishments;
• Is set up similar to a cafeteria with self-serve stations;

• Is staffed by a paid chef and       ;
• Is located in a       in the vicinity of an       store, a       store and       other
eating establishments.
You have       members on your board of directors. Your only income has been from the receipts from E. Your

expenses consist of cost of sales, occupancy expenses, insurance, and have only been for E’s operations.

You stated that you intend to operate schools to help people       and to
through education as well as bring       as intervention methods for those at risk.

Finally, you indicated that you operate B to pay for educational materials to advance your exempt purpose of
creating schools to encourage individuals to participate in their personal healing.

Law

Section 501(c)(3) of the Code provides for the recognition of exemption of organizations that are organized and
operated exclusively for religious, charitable or other purposes as specified in the statute. No part of the net
earnings may inure to the benefit of any private shareholder or individual.

Treasury Regulation Section 1.501(c)(3)-1(a)(1) states that, in order to be exempt as an organization described
in Section 501(c)(3) of the Code, an organization must be both organized and operated exclusively for one or
more of the purposes specified in such Section. If an organization fails to meet either the organizational test or
the operational test, it is not exempt.

Treas. Reg. Section 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as operated exclusively
for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of
such exempt purposes specified in Section 501(c)(3) of the Code. An organization will not be so regarded if
more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

Treas. Reg. Section 1.501(c)(3)-1(d)(2) defines the term charitable as including the relief of the poor and
distressed or of the underprivileged, and the promotion of social welfare by organizations designed to lessen
neighborhood tensions, to eliminate prejudice and discrimination, or to combat community deterioration. The
term “charitable” also includes lessening of the burdens of government.

Treasury Regulation Section 1.501(c)(3)-1(e)(1) states an organization may qualify for tax exemption under
Section 501(c)(3) of the Code although it operates a trade or business as a substantial part of its activities,

1. If the operation of such trade or business is in furtherance of the organization’s exempt purpose or
purposes,

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

2. and also, if the organization is not organized or operated for the primary purpose of carrying on an
unrelated trade or business, as defined in Section 513 of the Code.

In Harding Hospital, Inc. v. United States, 505 F.2d 1068, 1071 (6th Cir. 1974), the court held that an
organization has the burden of proving that it satisfies the requirements of the particular exemption statute. The
court noted that whether an organization has satisfied the operational test is a question of fact.

In La Verdad v. Commissioner, 82 T.C. 215 (1984), the administrative record did not demonstrate that the
organization would operate exclusively in furtherance of an exempt purpose. Therefore, denial of organization’s
request for tax-exempt status was reasonable.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the court found that a corporation formed to
provide consulting services did not satisfy the operational test under Section 501(c)(3) of the Code because its
activities constituted the conduct of a trade or business that is ordinarily carried on by commercial ventures
organized for profit. Its primary purpose was not charitable, educational, or scientific, but rather commercial.
In addition, the court found that the organization's financing did not resemble that of the typical Section
501(c)(3) organizations. It had not solicited, nor had it received, voluntary contributions from the public. Its
only source of income was from fees from services, and those fees were set high enough to recoup all projected
costs and to produce a profit. Moreover, it did not appear that the corporation ever planned to charge a fee less
than “cost.” And finally, the corporation did not limit its clientele to organizations that were Section 501(c)(3)
exempt organizations.

In Easter House v. U.S., 12 Cl. Ct. 476, 486 (1987), aff'd, 846 F. 2d 78 (Fed. Cir.) cert. denied, 488 U.S. 907,
109 S. Ct. 257, 102 L. Ed. 2d 246 (1988), the court found an organization that operated an adoption agency was
not exempt under Section 501(c)(3) of the Code because a substantial purpose of the agency was a nonexempt
commercial purpose. The court concluded that the organization did not qualify for exemption under Section
501(c)(3) because its primary activity was placing children for adoption in a manner indistinguishable from that
of a commercial adoption agency. The court rejected the organization's argument that the adoption services
merely complemented the health-related services to unwed mothers and their children. Rather, the court found
that the health-related services were merely incident to the organization's operation of an adoption service,
which, in and of itself, did not serve an exempt purpose. The organization's sole source of support was the fees
it charged adoptive parents, rather than contributions from the public. The court also found that the organization
competed with for-profit adoption agencies, engaged in substantial advertising, and accumulated substantial
profits. Accordingly, the court found that the "business purpose, and not the advancement of educational and
charitable activities purpose, of plaintiff's adoption service is its primary goal" and held that the organization
was not operated exclusively for purposes described in Section 501(c)(3). Easter House, 12 Cl. Ct. at 485-486.

In Living Faith, Inc. v. Commissioner, 950 F.2d 365 (1991), the Court of Appeals upheld a Tax Court decision
that an organization operating restaurants and health food stores in a manner consistent with the doctrines of the
Seventh Day Adventist Church did not qualify for exemption under Section 501(c)(3) of the Code because the
organization was operated for a substantial nonexempt commercial purpose. The court found that the
organization's activities were "presumptively commercial" because the organization was in competition with
other restaurants, engaged in marketing, and generally operated in a manner similar to commercial businesses.

Application of Law

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

4

You are not as described in Section 501(c)(3) of the Code because you do not meet the operational test as per
Treas. Reg. Section 1.501(c)(3)-1(a)(1). Your primary activity consists of operating E which is open to the
general public. You operate in a manner consistent and in competition with other eating establishments.

You are not operating exclusively for charitable purposes as required under Treas. Reg. Section 1.501(c)(3)-
1(c)(1). Your only activity since your inception is the operation of E whose prices and hours of operation are the
same as those of similar eating establishments. As required by Treas. Reg. Section 1.501(c)(3)-1(d)(2), you
have not shown that your operations accomplish exclusively charitable or educational purposes.

Operating an eating establishment on a regular and continuous basis is an unrelated trade or business for profit
within the meaning of Section 513 of the Code. Pursuant to Treas. Reg. Section 1.501(c)(3)-1(e)(1), you do not
meet the requirements for recognition of tax exemption under Section 501(c)(3) of the Code as your primary
purpose as indicated by your only activity over the last x year is the operation of an unrelated trade or business
for profit within the meaning of Section 513 of the Code.

You are similar to the organizations described in B.S.W. Group, Inc., Easter House, and Living Faith. You are
in direct competition with other eating establishments in the area. Like a commercial for-profit business, you
are open to the general public on a regular basis and your customers are not limited to a charitable class of
individuals. Your only income has been from E’s operations. You use your receipts from E to pay for the cost
of sales, occupancy expenses, insurance and salaries. These facts show you are operating for a substantial
nonexempt commercial purpose rather than for a tax-exempt purpose.

Per the court case, Harding Hospital, an organization seeking tax-exempt status under Section 501(c)(3) of the
Code carries the burden of proving that it satisfies the requirements of the statute. You have been planning to
operate educational programs throughout the world. However, since your inception of x years ago, you have
primarily operated E. Therefore, the facts show that you do not qualify under Section 501(c)(3) of the Code.

Like the organization in the court case, La Verdad v. Commissioner, the information in the administrative
record does not demonstrate that you would operate exclusively in furtherance of an exempt purpose. Therefore,
denial of your request for tax-exempt status is reasonable.

Conclusion:
Based on the facts and information submitted, you are not operated exclusively for exempt
purposes because you are operated in a commercial manner.

If you agree

If you agree with our proposed adverse determination, you don’t need to do anything. If we don’t hear from
you within 30 days, we’ll issue a final adverse determination letter. That letter will provide information on
your income tax filing requirements.

If you don't agree
You have a right to protest if you don’t agree with our proposed adverse determination. To do so, send us a
protest within 30 days of the date of this letter. You must include:

• Your name, address, employer identification number (EIN), and a daytime phone number

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

5
• A statement of the facts, law, and arguments supporting your position

• A statement indicating whether you are requesting an Appeals Office conference

• The signature of an officer, director, trustee, or other official who is authorized to sign for the
organization or your authorized representative

• The following declaration:

For an officer, director, trustee, or other official who is authorized to sign for the organization:
Under penalties of perjury, I declare that I have examined this request, or this modification to the
request, including accompanying documents, and to the best of my knowledge and belief, the request
or the modification contains all relevant facts relating to the request, and such facts are true, correct,
and complete.

Your representative (attorney, certified public accountant, or other individual enrolled to practice before the
IRS) must file a Form 2848, Power of Attorney and Declaration of Representative, with us if they haven’t
already done so. You can find more information about representation in Publication 947, Practice Before the
IRS and Power of Attorney.

We’ll review your protest statement and decide if you gave us a basis to reconsider our determination. If so,
we’ll continue to process your case considering the information you provided. If you haven’t given us a basis
for reconsideration, we'll send your case to the Appeals Office and notify you. You can find more information
in Publication 892, How to Appeal an IRS Decision on Tax-Exempt Status.

If you don’t file a protest within 30 days, you can’t seek a declaratory judgment in court later because the
law requires that you use the IRC administrative process first (IRC Section 7428(b)(2).

Where to send your protest
Send your protest, Form 2848, if applicable, and any supporting documents to the applicable address:

U.S. mail: Street address for delivery service:
Internal Revenue Service Internal Revenue Service

EO Determinations Quality Assurance EO Determinations Quality Assurance
Mail Stop 6403 550 Main Street, Mail Stop 6403

P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201

You can also fax your protest and supporting documents to the fax number listed at the top of this letter. If you
fax your statement, please contact the person listed at the top of this letter to confirm that they received it.

You can get the forms and publications mentioned in this letter by visiting our website at www.irs.gov/forms-
pubs or by calling 800-TAX-FORM (800-829-3676). If you have questions, you can contact the person listed at
the top of this letter.

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K


Contacting the Taxpayer Advocate Service
The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that can help protect your

taxpayer rights. TAS can offer you help if your tax problem is causing a hardship, or if you’ve tried but haven’t
been able to resolve your problem with the IRS. If you qualify for TAS assistance, which is always free, TAS
will do everything possible to help you. Visit www.taxpayeradvocate.irs.gov or call 877-777-4778.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K